Federal Open Market Committee (FOMC) meeting last week - most hawkish Fed since beginning of year

Equities and bonds fell sharply with the Greenback strengthening, thanks to the Fed providing further hints that the historically longest and largest easing scheme might be tapered as early as this year, and ceased in middle of next year if the U.S. economic recovery moves toward the Fed's forecast.

If we put the words "economic conditions" in the game, the latest FOMC statement didn't really convey the message as the market reacted, because no one knows how the recovery will be. Labor market conditions showed further improvement in recent months, on balance, but the unemployment rate remains elevated. Thus, we are more willing to take this period as a "trial run," instead of setting up new positions for the regime change immediately.

Based on the overall presentation from Ben Bernanke, he highlighted that the Fed's easing pace will be adjusted if the economic environment requests it, and it will be on both sides. Even so, the word "adjustment" was heard more often compared to the conference in May. The most important message appeared in the Q&A session: Bernanke mentioned that the Fed would probably make some adjustments to its USD85 billion monthly bond buying later in 2013 and cease QE3 around mid-2014, as long as economic conditions, such as inflation and the labor market, are in line with Fed projections.

I raise some cautiousness here, not a disagreement to the current market sentiment. Why should we be so certain on a robust recovery purely based on the improving U.S. labor market in recent months and improving Euro Zone economic data? What if peripherals in Europe kick off another round of a "bail-out" saga, or China's slowdown lags global recovery? These possibilities still exist.

However, the FOMC showed a more "hawkish" tone this time, forecasting the unemployment rate slightly lower compared to its previous meeting, and the few upcoming labor market data releases will be still closely monitored. Having said that, some hurdles need to be crossed before adjusting to a slower easing pace. The FOMC expects the economy to grow 3% to 3.5% next year, driving the unemployment rate down to 6.5% to 6.8%, which will obviously trigger a "QE Ending" if reality moves according to the Fed's projections.

China - Will reform lead to another "hard landing"?

We have no doubt that China entered another round of slowing down due to subdued domestic and external demand, as well as shadow banking fears. After it released the full set of economic releases in May, it confirmed slow momentum for growth in Q2 and toward the end of the year. Key data, such as Inflation, Trades and Aggregate Financing, suggested weak global and domestic demand at best.

A new theme is on the table now - the liquidity issue. The SHIBO and 7-day repo rate became key indicators in China's capital market pricing. The People's Bank of China (PBOC) denied injecting liquidity until last Friday, trying to pass the message of its determination to collaborate with local officials to put reform as its priority. Rumors came out last week that one of the largest banks in China was close to default if the PBOC didn't react last Friday. The Industrial and Commercial Bank of China (ICBC) also stopped its ATM operation service last Saturday due to "technical reasons."

According to the latest M2 and New Yuan Loan, liquidity shouldn't be a problem in the Chinese banking system. The only explanation could be cash parked in the wrong place. As we knew, many large corporations continued putting large capital in wealth management products (WMP) issued by trusts.

Nevertheless, I expect monetary policy in China to remain tight before it releases the 2Q Gross Domestic Product (GDP) next month. Some accommodative policies might be seen if data goes to the extreme. In the PBOC's latest statements, Governor Zhou Xiaochuan highlighted that the monetary policy could be adjusted in either direction according to the economic condition. Interbank lending rates remain key indicators gauging the "bull and bear" sentiment in the capital market.

Investment Insights

Continue with underweight commodity currencies in near term

Underweight commodity currencies are our main theme since speculation on the Fed's tapering increased, and an increasing number of investors believe it's real.

Together with the recent Chinese credit crunch on the table without much assistance from the PBOC, commodity currencies such as the Aussie and Kiwi might be "under the water" for a prolonged period.

On the technical side, the NZDUSD fell into a clear downtrend channel since the beginning of the May. With ongoing negative catalysts for commodity currencies, the NZDUSD may face some headwinds near 0.7890, and supported at 0.75 in the near term.